Product Development Economics

Abstract

This Chapter addresses the importance of evaluating economic considerations in the project design phase of the product development. It also discusses the different economic strategies that the company should consider relative to its time-of-entry into the market for a specific product. Lastly, it discusses what would be best for the company’s economic interest, i.e. product replacement or product improvement. All of the above considerations go a long way in determining the success of the product.

Background

“Development is the set of activities that transform a concept for satisfying perceived needs into a product or service that is ready for the market,” (Johnson & Kirchain, 2011). In today’s technology driven market, the importance of product development is well established. The development phase not only helps to determine the functional performance of a product but also helps to determine the financials of the product itself. In fact it is reported that between 70 and 90 percent of the project’s costs are decided in the early phases of the product development (Bhimani & Mulder, 2001; Shehab & Abdalla, 2001). The rapid escalation in technology has led to a shift in parameters that companies compete in to achieve maximum profits. One of these is time-based competition, which is discussed in subsequent sections.

Time-based Competition

Concept that time is a resource and a firm that make better use of time (in responding to the changing market situations) acquires a competitive advantage. The term was coined by the consultant George of the Boston Consulting Group and popularized by his 1998 book Competing Against Time, in which he talks about the term time-based competition after he realized how important it is to time the release of your product, and how long your product development cycle is. He recognized the correlation between the change in profitability of a product and the duration of its product cycle. In economics terms, he observed that sooner a finished product was released in the market, it implied lesser development costs and after the introduction of the product, being the pioneers in that field, i.e. being an innovator/the first one to release the product, would lead to greater profits. In today’s world this is more relevant than ever before considering the multiple patent wars going on i.e. the Apple vs. Samsung patent wars. It is very important to be able to provide something to the market that is not there already. This is made possible only when product development cycles are short and efficient. However, it is also important to weight the decrease in development cycles, versus the “finished-ness” of the product, which is discussed in later sections of this article. For example, Clark (1989) estimates that if a certain car cost 10,000 dollars, every day’s delay in the release of the product represents a million dollar loss for the company. Another McKinsey study reports that a company loses about ten times of its after-tax profits for shipping a product six-month’s late as compared to what it would lose by overspending 50% more on product development. In their 1991 book Developing Products in Half the Time, Smith and Reinertsen argue that it is necessary to adopt an incremental approach to product innovation in order to reduce time to market. This is because incremental product innovation reduces the amount of effort and learning that must be done and, consequently, the amount of time needed to invest in the new product prior to its launch. Financially its implications involve reduction of development costs since the same processes as before are being carried out by essentially the same amount of labor as the reduction in the time-to-market is stemming from concurrent-phase development and cross-functional development teams; the labor costs are significantly reduced. Such a perspective has led some companies (e.g., General Electric, Hewlett Packard) to adopt time-to-market as their principal product development metric. (Cohen et al., 1996).

Minimizing the Time-to-Market and the Balance with Product Performance

However, on the flipside of the argument for shorter product development cycles, it can clearly be seen that there is a trade-off between minimizing the time-to-market, and optimal performance of the new product. Even a minor increase in the performance of the product could help the company grab a significant portion of the market share. While on the other hand, this improvement in the product’s performance might take too long to be achieved and thus the company could lose out on the window of opportunity that it may have had in releasing the product without the additional improvement. A very good example of such a case would be Apple Computer’s Lisa Macintosh development in the early 1980s. The project was very ambitious and aimed to greatly increase the product performance as well as to improve the general manufacture process, but its introduction that was late by several quarters drove apple earnings down to about half their initial value as it started out with in 1983.

The development capability hurdle needed to profitably undertake a new project increases with the total existing product performance of all products readily available in the market. It decreases with the product category demand rate, the profit margin, the market share lost to the competitors, and the window of opportunity of releasing the new product. One of the most important things to remember is that an improvement in the product’s performance does not necessarily guarantee a shorter time-to-market (Cohen et al., 1996).

The basic breakdown of Cohen’s findings are that if performance improvements are additive in nature, most of the limited time should be spent on the stage that leads to the biggest net improvement, and is the most productive. Another observation they made was that faster was not better if the product being replace has a high margin or if the new product has a large market potential. It is always the best strategy to take more time developing the product better if the product is going to face an intermediate rivalry in the market. Care needs to be taken in minimizing the break-even time as it may lead to a premature product introduction (Cohen et al., 1996).

Case Study: Hewlett Packard

Hewlett Packard realized this balance between the two objectives of high product performance target and a reduced time-to-market, with their BET metric i.e. Break-Even Time, which was aimed at reducing the break-even time of their products by half. (Smith & Reinertsen, 1991).

Figure 1 depicts the return map employed by HP for managing the development process of a new pocket calculator. The breakeven point is when the total cumulative investment in the development of the project is equal to the total cumulative net revenue. Reducing break-even time can motivate the product development team to address the crucial balance between a high product performance target and a short time-to-market. A significant improvement in the product performance target is likely to increase the slope of the sales curve, at the cost of delaying the new product launch. Incremental product improvements on the other hand, are likely to generate sales curve that are less steep but which bring revenues to the firm earlier. Again this trade-off varies from industry to industry and product to product and needs to be studied closely, before the development strategy is chosen. (Cohen et al., 1996).

Application to Senior Design Project

The Blue Team’s Senior Project focuses on the development of a solar insolation calibrator. When thinking about how we can achieve an acceptable balance between our product’s performance and its development cycle, one of the most important things that needs to be considered is to recognize and understand that product performance improvement processes have a multistage nature. We need to evaluate each and every decision we make about out project in terms of design and think if the amount of time/resources spent on the implementation of a certain feature contributes enough to the product’s performance, i.e. adds at least as much as the value of resources spent, if not more to it. It is helpful to study the competitors, the market, already existing comparable products, and the nature of the product. Other things to be considered are the productivity of certain design phases and the return on the product improvement developmental processes.

Conclusion

In conclusion, there exists a very delicate balance between minimizing the product development cycle to be able to push products in the market at a faster speed, and the new product’s performance. This balance can be achieved by carefully studying the competitors, the market, already existing comparable products, and the nature of the product.

Johnson, M. D., & Kirchain, R. E. (2011). The importance of product development cycle time and cost in the development of product families. Journal of Engineering Design, 22(2), 87–112. DOI: 10.1080/09544820902960058